Extra Help:

Start with Operating Profit, After Tax

• Technical Term: EBIT × (1 - Tax Rate), also known as NOPAT.

• What it Really Means: Let's figure out how much profit the company's core business actually made. We look at the profit from just selling its products (like phones or cars), before we account for any payments to banks for loans. Then, we calculate the taxes on that pure, operational profit.

• Analogy (Your Salary): Imagine you have a salary and a separate rental property. This step is like looking only at your salary's paycheck, after taxes. We are ignoring any income or expenses from the rental property for now, just focusing on the profit from your main job. This gives us the true, after-tax profitability of the core business itself.

Add Back Depreciation & Amortization

• Technical Term: + D&A

• What it Really Means: Depreciation is an accounting idea, not a cash payment. It's like an expense for the "wear and tear" on the company's assets. Each year, an accountant reduces the value of a machine on paper, and this counts as an "expense" that lowers the company's profit.

• Analogy (Your Delivery Van): Imagine your company owns a delivery van. Every year, your accountant says the van is worth $5,000 less, and records that as a $5,000 "depreciation expense." But did you actually write a check to someone for $5,000? No. No cash left the building. Since our goal is to count real cash, we have to add that imaginary $5,000 expense back into our cash pile.

Subtract Actual Cash Spent on Big Assets

• Technical Term: - Capital Expenditures (Capex)

• What it Really Means: This is the opposite of depreciation. This is the real cash the company spent during the year buying or upgrading its long-term assets.

• Analogy (Buying a NEW Van): While depreciation on the old van was a non-cash expense, going out and spending $40,000 in cash on a brand new van is a very real cash outflow. This spending doesn't show up on the main income statement, so we have to subtract it here to get an honest picture of the company's cash situation.

4. Adjust for Day-to-Day Cash Needs

• Technical Term: - Δ Net Working Capital (ΔNWC)

• What it Really Means: This is the cash needed to run the daily operations - the money tied up between paying your suppliers and getting paid by your customers. We need to account for any change in this amount.

Example: Apple

• Accounts Receivable (AR) = Money customers owe Apple but haven’t paid yet. For example, when Apple sells iPhones to a mobile carrier (like AT&T) and lets them pay in 60 days, that sale goes into AR until the cash arrives.

• Accounts Payable (AP) = Money Apple owes suppliers but hasn’t paid yet. For example, when Apple buys chips from TSMC and agrees to pay them in 45 days, that bill sits in AP until payment.

ΔNWC in action:
If Apple’s Accounts Receivable grows faster than Accounts Payable, it means:

• More cash is stuck waiting for carriers and retailers to pay Apple (AR up)

• But Apple is still paying its suppliers on time (AP not increasing much)

This ties up cash in operations - Apple has effectively funded its customers while not delaying payments to suppliers. That’s a use of cash.

On the flip side, if Apple collects customer payments faster while delaying payments to suppliers, it frees up cash - a source of cash.